Background Investigations as an anti-fraud risk management tool

August 2013 | SPECIAL REPORT: WHITE-COLLAR CRIME

Financier Worldwide Magazine

August 2013 Issue

There should be no excuse for acquiring a company, merging with a company or financing a company wherein the remaining owners or management team members have a history of fraud and corruption, when a thorough background investigation would reveal current or past indiscretions such as fraud and corruption. What follows is a selection of revelations that have been revealed during background investigations.

Bribing a bank officer/felony arrest

Undisclosed to a prospective new lender, the CEO of a prospect company was in jail awaiting trial for attempting to bribe his current account officer with cash when the prospective lender was conducting its onsite due diligence. The day the prospective lender was interviewing officers of the new prospect, the CFO told the bank group that the CEO was having eye surgery but, in fact, he was in jail awaiting trial for attempting to bribe his current lender. So we have here both a serious felony charge against the CEO and an attempted cover up by the company CFO.

An ‘on-site’ court house search in the proper jurisdiction revealed this pending ‘sealed’ criminal court case against the CEO, where online research did not.

Securities fraud

Undisclosed to the lender, the CEO of a US public company was found to have been under investigation for securities fraud in Canada because of allegations during his tenure as the CEO of a Canadian public company prior to being hired as CEO by the lender’s prospect. The deal was killed by the lender, and the CEO was fired by the prospect’s board of directors. The subject was subsequently convicted of securities fraud in Toronto.

As the subject of the investigation was a Canadian citizen, a media search performed in Canada brought the securities fraud case in Canada to light. Additionally, US media searches, which are a routine part of investigations, should always include the Canadian media across the border. A media source in Toronto picked up the outstanding securities fraud case, which led to further inquiry with the Toronto regulatory authorities.

Accounting fraud

Undisclosed by the private equity firm that referred the prospect to the lender and by the prospect’s CEO, the CEO of the prospect company was a convicted felon for two separate crimes of tax fraud and tax evasion, the most recent conviction resulting in a prison sentence served within the past year. The lender walked away from the deal and its source.

The key to this discovery was simply the lender’s decision to instruct an independent background investigation in the first place. The lender followed a ‘best practice’ routine to engage this work to be performed independently when in doubt about the reputation of the background investigations firm being used by the source private equity firm, or when the source refuses to share the results of a background investigation that had been presumably performed. A criminal litigation search revealed the two felonies. Upon further inquiry into its source, the private equity firm informed the lender that this felony finding should not be material to its decision to fund.

Personal act of indiscretion

Undisclosed to the investor, the CEO of a private company was found to have sexually assaulted and molested his then four-year-old daughter, 12 years before. He subsequently remarried, had another daughter – who at the time of the background investigation was four years old – and started another business. The prospective investor, who had met with the CEO and his current wife, business partner and investor many times, is convinced that his wife and partners were unaware of his past transgressions. The investor, having reviewed the results of the background investigation, walked away from the deal.

A ‘relocation search’ into a jurisdiction in which the subject had lived 15 years before brought the sexual assault/child molestation case to light. The subject was using a derivation of his name used when the crime was committed and a stolen social security number.

Brand wasting and reputation risk

The daughter and future son-in-law of a prospect company’s CEO were killed execution-style in his villa in Switzerland within just one day of the completion of an investigative background report. The equity investor and asset-based lending subsidiary of a major capital markets institution, representing a national brand name, was also the agent bank in the proposed consortium financing. The prospect CEO was a foreign national with a US company with assets to secure the loan. The investor and lender walked away from the deal and also protected its good brand and reputation.

Foreign country research into property ownership and criminal history brought this tragedy into focus, not just in the country of domicile, but also in the country where the subject owned a second home villa.

Felony – from the sublime to the ridiculous

Undisclosed to the lender, the CEO of a US public company was found to have been convicted for killing an endangered species in a public park. He was an aspiring member of a closet militia group that required such an offence in order to pass the hazing requirements for membership. He failed the militia group’s membership test and the background investigation test. The CEO lost his job with the prospect company, but not until the lender backed away from the deal.

There was nothing unusual here, just good research into a second jurisdiction where the subject owned a recreation cabin as a second home. The subject didn’t think he would get caught – by the park ranger who caught him in point blank range or by a background investigations team. A second ingredient was the subject’s stupidity, a common trait among ‘bulletproof’ executives.

Just a bad actor

The person investigated was CEO of an internet marketing company. Undisclosed to the lender at the time of its proposal being executed, the CEO had the following outstanding unaccounted-for issues: (i) he was using 20 aliases; (ii) he was sentenced to four years in prison and ordered to pay $2m in restitution in a national telemarketing scam based upon charges of bank fraud, conspiracy to defraud a lending institution, wire and mail fraud and others too numerous to mention; (iii) he had a pending criminal charge of aggravated child abuse; (iv) he had a pending civil fraud case for violation of Deceptive and Unfair Trade Practices; and (v) a YouTube documentary was also found detailing allegations of fraud in the practices of the subject’s current internet marketing business.

Thorough research into public court records, using a combination of independent online and onsite court house search methodology revealed this extensive background information.

Additional best practice tips

In approaching background investigations, parties should be consistent about the methodology employed. Investors and lenders that perform background investigations by exception rather than as a standard practice may be compromised exceptionally, when fraud occurs.

An investigation must include a thorough research effort into determining all of the relevant jurisdictions – counties or countries in which the subject has resided, otherwise owned real property or done business.

Research must also be performed in every jurisdiction where it has been determined the subject has resided, owned real property or done business. To overlook even one jurisdiction could leave out the one where the fraud or ‘deal killer’ issue resides.

Finally, an investigation into public records (i.e., civil and criminal litigation histories, tax liens, judgments and bankruptcies) should always include a combination of independent onsite and online court house research. In the US alone, we find adverse public record information in approximately 30 percent of cases as a result of performing onsite research that we don’t find when performing online research, using the best databases available – a percentage too high to ignore.

Jerry Oldham is co-founder, chairman and CEO of 1stWEST Financial Corporation. He can be contacted on +1 (303) 670 3443 or by email: j.oldham@1stwest.com.